UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-30903
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VIRAGE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 38-3171505
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
411 BOREL AVENUE, 100S
SAN MATEO, CALIFORNIA 94402-3116
(650) 573-3210
(Address, including zip code, and telephone number, including area code,
of the registrant's principal executive offices)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
The number of outstanding shares of the registrant's Common Stock,
$0.001 par value, was 20,978,790 as of February 2, 2003.
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VIRAGE, INC.
INDEX
PAGE
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - December 31, 2002 and
March 31, 2002 ....................................................... 1
Condensed Consolidated Statements of Operations -- Three and
Nine Months Ended December 31, 2002 and 2001 ......................... 2
Condensed Consolidated Statements of Cash Flows -- Nine Months Ended
December 31, 2002 and 2001 ........................................... 3
Notes to Condensed Consolidated Financial Statements ................... 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ......................................... 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk ........ 37
Item 4. Controls and Procedures ........................................... 37
PART II: OTHER INFORMATION
Item 1. Legal Proceedings ................................................. 38
Item 2. Changes in Securities and Use of Proceeds ......................... 38
Item 3. Defaults Upon Senior Securities ................................... 39
Item 4. Submission of Matters to a Vote of Security Holders ............... 39
Item 5. Other Information ................................................. 39
Item 6. Exhibits and Reports on Form 8-K .................................. 40
Signature ................................................................. 41
Certifications ............................................................ 42
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
VIRAGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
December 31, March 31,
2002 2002
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ........................ $ 2,923 $ 4,586
Short-term investments ........................... 15,949 26,108
Accounts receivable, net ......................... 2,037 2,366
Prepaid expenses and other current assets ........ 498 220
--------- ---------
Total current assets ......................... 21,407 33,280
Property and equipment, net ........................ 1,931 3,701
Other assets ....................................... 2,389 2,571
--------- ---------
Total assets ................................. $ 25,727 $ 39,552
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................. $ 444 $ 831
Accrued payroll and related expenses ............. 1,455 2,376
Accrued expenses ................................. 2,645 2,946
Deferred revenue ................................. 3,235 3,050
--------- ---------
Total current liabilities .................... 7,779 9,203
Deferred rent ...................................... -- 290
Commitments and contingencies
Stockholders' equity:
Preferred stock .................................. -- --
Common stock ..................................... 21 21
Additional paid-in capital ....................... 121,427 121,387
Deferred compensation ............................ (1,070) (2,425)
Accumulated deficit .............................. (102,430) (88,924)
--------- ---------
Total stockholders' equity ................... 17,948 30,059
--------- ---------
Total liabilities and stockholders' equity ... $ 25,727 $ 39,552
========= =========
See accompanying notes.
1
VIRAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
December 31, December 31,
--------------------------- ---------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenues:
License revenues ..................................... $ 1,339 $ 1,478 $ 4,623 $ 6,292
Service revenues ..................................... 1,975 3,290 5,203 7,000
Other revenues ....................................... -- 20 -- 232
-------- -------- -------- --------
Total revenues ..................................... 3,314 4,788 9,826 13,524
Cost of revenues:
License revenues ..................................... 195 202 542 534
Service revenues(1) .................................. 1,090 2,122 3,308 7,059
Other revenues ....................................... -- 5 -- 153
-------- -------- -------- --------
Total cost of revenues ............................. 1,285 2,329 3,850 7,746
-------- -------- -------- --------
Gross profit ........................................... 2,029 2,459 5,976 5,778
Operating expenses:
Research and development(2) .......................... 1,781 2,117 6,607 6,934
Sales and marketing(3) ............................... 2,357 3,858 9,104 12,720
General and administrative(4) ........................ 963 1,284 3,174 3,946
Stock-based compensation ............................. 291 719 1,026 2,257
-------- -------- -------- --------
Total operating expenses ........................... 5,392 7,978 19,911 25,857
-------- -------- -------- --------
Loss from operations ................................... (3,363) (5,519) (13,935) (20,079)
Interest and other income, net ......................... 101 315 429 1,295
-------- -------- -------- --------
Net loss ............................................... $ (3,262) $ (5,204) $(13,506) $(18,784)
======== ======== ======== ========
Basic and diluted net loss per share ................... $ (0.16) $ (0.26) $ (0.65) $ (0.93)
======== ======== ======== ========
Shares used in computation of basic and
diluted net loss per share ........................... 20,899 20,366 20,786 20,249
======== ======== ======== ========
(1) Excluding $5 and $15 in amortization of employee deferred stock-based
compensation for the three and nine months ended December 31, 2002,
respectively ($56 and $199 for the three and nine months ended December
31, 2001, respectively).
(2) Excluding $24 and $70 in amortization of employee deferred stock-based
compensation for the three and nine months ended December 31, 2002,
respectively ($102 and $321 for the three and nine months ended
December 31, 2001, respectively).
(3) Excluding $28 and $83 in amortization of employee deferred stock-based
compensation for the three and nine months ended December 31, 2002,
respectively ($211 and $670 for the three and nine months ended
December 31, 2001, respectively).
(4) Excluding $234 and $858 in amortization of employee deferred
stock-based compensation for the three and nine months ended December
31, 2002, respectively ($350 and $1,067 for the three and nine months
ended December 31, 2001, respectively).
See accompanying notes.
2
VIRAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
December 31,
----------------------------
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................................................... $(13,506) $(18,784)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ............................................................ 1,870 2,223
Loss on disposal of assets ............................................................... 106 263
Amortization of deferred compensation related to
stock options and issuance of stock options to consultants ............................. 1,113 2,781
Amortization of technology right ......................................................... 27 26
Amortization of warrant fair values ...................................................... 11 657
Changes in operating assets and liabilities:
Accounts receivable .................................................................... 329 (30)
Prepaid expenses and other current assets .............................................. (278) 37
Other assets ........................................................................... 155 --
Accounts payable ....................................................................... (387) (167)
Accrued payroll and related expenses ................................................... (921) (372)
Accrued expenses ....................................................................... (301) 8
Deferred revenue ....................................................................... 185 (216)
Deferred rent .......................................................................... (290) 145
-------- --------
Net cash used in operating activities ...................................................... (11,887) (13,429)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ......................................................... (206) (361)
Purchase of short-term investments ......................................................... (52,500) (53,508)
Sales and maturities of short-term investments ............................................. 62,659 53,837
-------- --------
Net cash provided by (used in) investing activities ........................................ 9,953 (32)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options, net of repurchases ................................ 80 3
Proceeds from employee stock purchase plan ................................................. 191 766
-------- --------
Net cash provided by financing activities .................................................. 271 769
-------- --------
Net decrease in cash and cash equivalents .................................................. (1,663) (12,692)
Cash and cash equivalents at beginning of period ........................................... 4,586 19,680
-------- --------
Cash and cash equivalents at end of period ................................................. $ 2,923 $ 6,988
======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES:
Book value of equipment write-downs ........................................................ $ 476 $ 506
Accumulated depreciation of equipment write-downs .......................................... $ 370 $ 243
Deferred compensation related to stock options ............................................. $ 69 $ 123
Reversal of deferred compensation upon employee termination ................................ $ 398 $ 761
See accompanying notes.
3
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002
(unaudited)
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and in accordance with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) necessary for a fair
presentation of the financial statements at December 31, 2002 and for the three
and nine month periods ended December 31, 2002 and 2001 have been included.
The condensed consolidated financial statements include the accounts of
Virage, Inc. (the "Company") and its wholly-owned subsidiaries, Virage Europe,
Ltd. and Virage GmbH. All significant intercompany balances and transactions
have been eliminated in consolidation.
Results for the three and nine months ended December 31, 2002 are not
necessarily indicative of results for the entire fiscal year or future periods.
These financial statements should be read in conjunction with the consolidated
financial statements and the accompanying notes included in the Company's Annual
Report on Form 10-K, dated June 14, 2002 as filed with the United States
Securities and Exchange Commission. The accompanying balance sheet at March 31,
2002 is derived from the Company's audited consolidated financial statements at
that date.
Revenue Recognition
The Company enters into arrangements for the sale of licenses of
software products and related maintenance contracts, application services and
professional services offerings; and also receives revenues under U.S.
government agency research grants. Service revenues include revenues from
maintenance contracts, application services, and professional services. Other
revenues are primarily U.S. government agency research grants.
The Company's revenue recognition policy is in accordance with the
American Institute of Certified Public Accountants' ("AICPA") Statement of
Position No. 97-2 ("SOP 97-2"), "Software Revenue Recognition", as amended by
Statement of Position No. 98-4, "Deferral of the Effective Date of SOP 97-2,
"Software Revenue Recognition"" ("SOP 98-4"), and Statement of Position No.
98-9, "Modification of SOP No. 97-2 with Respect to Certain Transactions" ("SOP
98-9") and is also consistent with the Securities and Exchange Commission's
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements." For each arrangement, the Company determines whether evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable, and
collection is probable. If any of these criteria are not met, revenue
recognition is deferred until such time as all criteria are met. The Company
considers all arrangements with payment terms extending beyond twelve months and
other arrangements with payment terms longer than normal not to be fixed or
determinable. If collectibility is not considered probable, revenue is
recognized when the fee is collected. Generally, no customer has the right of
return.
4
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
Arrangements consisting of license and maintenance. For those contracts
that consist solely of license and maintenance, the Company recognizes license
revenues based upon the residual method after all elements other than
maintenance have been delivered as prescribed by SOP 98-9. The Company
recognizes maintenance revenues over the term of the maintenance contract as
vendor specific objective evidence of fair value for maintenance exists. In
accordance with paragraph ten of SOP 97-2, vendor specific objective evidence of
fair value of maintenance is determined by reference to the price the customer
will be required to pay when it is sold separately (that is, the renewal rate).
Customers that enter into maintenance contracts have the ability to renew such
contracts at the renewal rate. Maintenance contracts are typically one year in
duration. Revenue is recognized on a per copy basis for licensed software when
each copy of the license requested by the customer is delivered.
Revenue is recognized on licensed software on a per user or per server
basis for a fixed fee when the product master is delivered to the customer.
There is no right of return or price protection for sales to domestic and
international distributors, system integrators, or value added resellers
(collectively, "resellers"). In situations where the reseller has a purchase
order or other contractual agreement from the end user that is immediately
deliverable upon, the Company recognizes revenue on the shipment to the
reseller, if other criteria in SOP 97-2 are met, since the Company has no risk
of concessions. The Company defers revenue on shipments to resellers if the
reseller does not have a purchase order or other contractual agreement from an
end user that is immediately deliverable upon or other criteria in SOP 97-2 are
not met. The Company recognizes royalty revenues upon receipt of the quarterly
reports from the vendors.
When licenses and maintenance are sold together with professional
services such as consulting and implementation, license fees are recognized upon
shipment, provided that (1) the criteria in the previous paragraph have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional services, and (3) the services do not include significant
alterations to the features and functionality of the software.
Should professional services be essential to the functionality of the
licenses in a license arrangement that contains professional services or should
an arrangement not meet the criteria mentioned above, both the license revenues
and professional service revenues are recognized in accordance with the
provisions of the AICPA's Statement of Position No. 81-1, "Accounting for
Performance of Construction Type and Certain Production Type Contracts" ("SOP
81-1"). When reliable estimates are available for the costs and efforts
necessary to complete the implementation services and the implementation
services do not include contractual milestones or other acceptance criteria, the
Company accounts for the arrangements under the percentage of completion
contract method pursuant to SOP 81-1 based upon input measures such as hours or
days. When such estimates are not available, the completed contract method is
utilized. When an arrangement includes contractual milestones, the Company
recognizes revenues as such milestones are achieved provided the milestones are
not subject to any additional acceptance criteria.
Application services. Application services revenues consist primarily
of web design and integration fees, video processing fees and application
hosting fees. Web design and integration fees are recognized ratably over the
contract term, which is generally six to twelve months. The Company generates
video processing fees for each hour of video that a customer deploys. Processing
fees are recognized as encoding, indexing and editorial services are performed
and are based upon time-based rates of video content. Application hosting fees
are generated by and based upon the number of video queries processed, subject
in most cases to monthly minimums. The Company recognizes revenues on
transaction fees that are subject to monthly minimums based upon the monthly
minimum rate since the Company has no further obligations, the payment terms are
normal and each month is a separate measurement period.
Professional Services. The Company provides professional services such
as consulting, implementation and training services to its customers. Revenues
from such services, when not sold in conjunction with product licenses, are
generally recognized as the services are performed provided all other revenue
recognition criteria are met.
5
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
Other revenues. Other revenues consist primarily of U.S. government
agency research grants that are best effort arrangements. The
software-development arrangements are within the scope of the Financial
Accounting Standards Board's ("FASB") Statement of Financial Accounting
Standards No. 68, "Research and Development Arrangements." As the financial
risks associated with the software-development arrangement rest solely with the
U.S. government agency, the Company is recognizing revenues as the services are
performed. The cost of these services are included in cost of other revenues.
The Company's contractual obligation is to provide the required level of effort
(hours), technical reports, and funds and man-hour expenditure reports.
Use of Estimates
The preparation of the accompanying unaudited condensed consolidated
financial statements requires management to make estimates and assumptions that
affect the amounts reported in these financial statements. Actual results could
differ from those estimates.
Cash Equivalents and Short-Term Investments
The Company invests its excess cash in money market accounts and debt
instruments and considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Investments
with an original maturity at the time of purchase of over three months are
classified as short-term investments regardless of maturity date, as all such
instruments are classified as available-for-sale and can be readily liquidated
to meet current operational needs. At December 31, 2002, all of the Company's
cash equivalents and short-term investments were classified as
available-for-sale and consisted of obligations issued by U.S. or state
government agencies and multinational corporations, maturing within one year.
Comprehensive Net Loss
The Company has adopted the FASB's Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130
establishes standards for the reporting and display of comprehensive income
(loss) and its components in a full set of general purpose financial statements.
To date, unrealized gains and losses have been insignificant and the Company has
had no other significant comprehensive income (loss), and consequently, net loss
equals total comprehensive net loss.
Net Loss per Share
Basic and diluted net loss per share are computed in conformity with
the FASB's Statement of Financial Accounting Standards No. 128, "Earnings Per
Share" ("FAS 128"), for all periods presented, using the weighted average number
of common shares outstanding less shares subject to repurchase.
6
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
The following table presents the computation of basic and diluted net
loss per share (in thousands, except per share data):
Three Months Ended Nine Months Ended
December 31, December 31,
-------------------- --------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net loss ....................... $ (3,262) $ (5,204) $(13,506) $(18,784)
======== ======== ======== ========
Weighted-average shares of
common stock outstanding ..... 20,902 20,474 20,797 20,400
Less weighted-average shares of
common stock subject to
repurchase ................... (3) (108) (11) (151)
-------- -------- -------- --------
Weighted-average shares used in
computation of basic and
diluted net loss per share ... 20,899 20,366 20,786 20,249
======== ======== ======== ========
Basic and diluted net loss per
share ........................ $ (0.16) $ (0.26) $ (0.65) $ (0.93)
======== ======== ======== ========
The Company has excluded all outstanding stock options, warrants and
shares subject to repurchase from the calculation of basic and diluted net loss
per share because these securities are antidilutive for all periods presented.
Such securities, had they been dilutive, would have been included in the
computation of diluted net loss per share using the treasury stock method.
Impact of Recently Issued Accounting Standards
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets ("FAS 144")," which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets and supersedes FAS 121 and the
accounting and reporting provisions of Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations for a Disposal of a Segment of a
Business." The Company adopted FAS 144 as of April 1, 2002 and, to date, the
adoption of this statement has not had a significant impact on the Company's
financial position and results of operations. The Company monitors its
long-lived assets, primarily its property and equipment, for impairment issues
as part of its on-going financial processes and the provisions of FAS 144 could
result in the Company recording additional charges in the future.
In November 2001, the FASB issued a Staff Announcement (the
"Announcement"), Topic D-103, which concluded that the reimbursement of
"out-of-pocket" expenses should be classified as revenue in the statement of
operations. The Company adopted the Announcement in its fiscal fourth quarter of
its year ended March 31, 2002 and the Announcement did not have a material
affect on the Company's operations, financial position or cash flows.
In July 2002, the FASB issued Statement of Financial Accounting
Standards No. 146, "Accounting for Costs Associated with Exit and Disposal
Activities ("FAS 146")." This statement revises the accounting for exit and
disposal activities under the FASB's Emerging Issues Task Force Issue 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity ("EITF 94-3")," by spreading out the reporting of expenses
related to restructuring activities. Commitment to a plan to exit an activity or
dispose of long-lived assets will no longer be sufficient to record a one-time
charge for most anticipated costs. Instead, companies will record exit or
disposal costs when they are "incurred" and can be measured at fair value, and
they will subsequently adjust the recorded liability for changes in estimated
cash flows. Companies may not restate previously issued financial statements for
the effect of the provisions of FAS 146 and liabilities that a company
previously recorded under EITF 94-3 are grandfathered.
7
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
During the three months ended December 31, 2002, the Company early
adopted FAS 146. The Company also adopted a plan that calls for the Company to
consolidate certain headquarters facilities in March 2003. As a result of this
early adoption of FAS 146, approximately $1,858,000 of charges related to the
Company's planned facility consolidation will be recorded as of the date the
Company ceases use of the space it intends to abandon (March 2003) instead of
the plan adoption date (December 2002) as prescribed under EITF 94-3. Based upon
the facts and circumstances around charges that the Company historically has
been required to record, the Company currently believes that the adoption of FAS
146 may affect the timing of, but ultimately will not have a materially
different impact on, its operations, financial position or cash flows.
In November 2002, a consensus was reached regarding the FASB's Emerging
Issues Task Force Issue 00-21, "Accounting for Revenue Arrangements with
Multiple Deliverables ("EITF 00-21")." EITF 00-21 prescribes that if
deliverables in a multi-element arrangement meet certain criteria, arrangement
consideration should be allocated among the separate units of accounting based
on each unit's relative fair values. Applicable revenue recognition criteria
should be considered separately for separate units of accounting. EITF 0-21 will
be applicable to agreements entered into in fiscal periods beginning after June
15, 2003. The Company does not believe EITF 00-21 will have a material effect on
its operations, financial position or cash flows.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation--Transition and
Disclosure ("FAS 148")." FAS 148 amends Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation ("FAS 123")," to
provide alternative methods of transition to FAS 123's fair value method of
accounting for stock-based employee compensation. FAS 148 also amends the
disclosure provisions of FAS 123 and Accounting Principles Board's Opinion No.
28, "Interim Financial Reporting," to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income and
earnings (loss) per share in annual and interim financial statements. FAS 148
does not require companies to account for employee stock options using the fair
value method of accounting (ie. the expensing of stock option grants in a
company's statement of operations). The Company will adopt FAS 148 in its fiscal
fourth quarter of its year ended March 31, 2003. FAS 148 will not have a
material effect on the Company's operations, financial position or cash flows as
the Company will continue to account for employee stock options using the
intrinsic value method of accounting. However, the Company will be required to
provide additional disclosures with its interim and annual financial statements
regarding the impact of employee stock options as if it had accounted for
employee stock options using the fair value method of accounting.
In December 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others ("FIN 45")." FIN 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The Company has adopted the disclosure requirements of
FIN 45 as of December 31, 2002. In addition, the Company is required to adopt
the initial recognition and measurement of the fair value of the obligation
undertaken in issuing the guarantee on a prospective basis for all guarantees
issued or modified after December 31, 2002. The Company does not believe FIN 45
will have a material effect on the Company's operations, financial position or
cash flows.
8
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
2. Commitments and Contingencies
In the normal course of business, the Company is subject to commitments
and contingencies, including operating leases, restructuring liabilities and
litigation including securities-related litigation and other claims in the
ordinary course of business. The Company records accruals for such contingencies
based upon its assessment of the probability of occurrence and, where
determinable, an estimate of the liability. The Company considers many factors
in making these assessments including past history and the specifics of each
matter. The estimate of the liability necessarily requires assumptions to be
made with respect to certain internal and external variables, which may affect
the ultimate actual amount of liability. However, actual results may differ from
these estimates if such assumptions later prove inaccurate. The Company reviews
its assessment of the likelihood of loss on any outstanding contingencies as
part of its on-going financial processes.
Commitments
In December 2002, the Company amended its lease for its headquarters
(the "Lease Amendment"). The Lease Amendment reduces, from December 2002 until
December 2003, the Company's rent rate to half of what the rent rate was under
the original operating lease agreement. In December 2003, and on each annual
anniversary thereafter through the Amendment's termination date of September
2006, the Company's rent rate will be adjusted to fair market value as to be
mutually determined by the Company and its landlord, subject to a minimum rate
that is equivalent to the Lease Amendment's initial reduced rate discussed above
(the "Minimum Rate").
In addition, the Company and its landlord will use best efforts to have
the landlord lease, to a third party, certain space that the Company intends to
abandon in March 2003. If the space is leased to a third party, the space will
be excluded from the Lease Amendment as of the date an agreement for the third
party lease is executed, subject to the Company guaranteeing its landlord the
Minimum Rate for the leased space. This guarantee will continue for a minimum of
24 months after the date of execution for the leased space.
Furthermore, if the Company is acquired by an unrelated entity, the
acquiror may terminate the lease obligation for a termination fee equal to 67%
of the total minimum monthly rent payable for the remaining term of the lease
subsequent to such acquisition.
In consideration for the above, the Company issued its landlord a
warrant to purchase 200,000 shares of the Company's common stock at $0.57 per
share (see Note 3). In addition, the Company will pay its landlord $1,250,000 on
January 2, 2003. On March 30, 2003, the landlord will release back to the
Company $1,250,000 of $2,000,000 of restricted cash used to collateralize a
letter of credit. The Company will also forego approximately $240,000 of
security deposits by March 31, 2003. The $2,000,000 of restricted cash and
$240,000 of security deposits are classified as other assets on the Company's
condensed consolidated balance sheets as of December 31, 2002 and March 31,
2002.
The Company will be obligated to remit an additional $750,000 to its
landlord if its landlord is able to lease this excess space for the benefit of
the Company. Should this occur, the Company's landlord will cancel the Company's
letter of credit in its entirety and release the final $750,000 of restricted
cash back to the Company. The Company estimates it will also incur approximately
$325,000 of other various expenses relating to certain provisions set forth
within the Lease Amendment.
In addition, the landlord, under certain limited conditions and
exceptions specified in the Lease Amendment, may have the option to extend the
term of the Lease Amendment for an additional five (5) years, with the base rent
for the renewal term based on fair market value.
9
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
The Company began amortizing the $2,565,000 of payments and other
expenses described above as rent expense over the life of the lease in December
2002. In March 2003, the Company anticipates abandoning approximately half of
its headquarters facility to facilitate the leasing of the space to a third
party. As a result of this and the Company's early adoption of FAS 146 (see Note
1), the Company expects to incur charges of approximately $1,858,000 during the
three months ended March 31, 2003. The charges are related to the write-off of
approximately half of the unamortized portion of the $2,565,000 of anticipated
payments described above and the accrual of approximately $750,000 relating to
the expected leasing of the excess space to a third party at a rate that is
below the Minimum Rate guarantee.
At December 31, 2002, the Company has contractual and commercial
commitments not included on its balance sheet primarily for its San Mateo,
California facility that it has an obligation to lease through September 2006.
For the remainder of the fiscal year ended March 31, 2003, the Company's total
commitments amount to $2,290,000. Future full fiscal year commitments are as
follows: $3,166,000 in 2004, $1,972,000 in 2005, $1,715,000 in 2006 and
$1,057,000 in 2007 ($10,200,000 in total commitments as of December 31, 2002).
The aforementioned amounts include estimates of expected fair market rental
rates in fiscal years ending March 31, 2004 to March 31, 2007 and the payments
of cash and forfeiture of other collateral of $1,489,000 and $1,076,000 for the
years ending March 31, 2003 and 2004, respectively, pursuant to the Lease
Amendment described above.
Guarantees
The Company generally provides a warranty for its software products and
services to its customers for a period of 90 days and accounts for its
warranties under the FASB's Statement of Financial Accounting Standards No. 5,
"Accounting for Contingencies." The Company's software products' media are
generally warranted to be free of defects in materials and workmanship under
normal use and the products are also generally warranted to substantially
perform as described in certain Company documentation. The Company's services
are generally warranted to be performed in a professional manner and to
materially conform to the specifications set forth in a customer's signed
contract. In the event there is a failure of such warranties, the Company
generally will correct or provide a reasonable work around or replacement
product. The Company's warranty accrual as of December 31, 2002 and March 31,
2002 was not significant and, to date, the Company's product warranty expense
has not been significant.
At December 31, 2002 and March 31, 2002, the Company has two letters of
credit that collateralize certain operating lease obligations of the Company and
total approximately $2,018,000. The Company collateralizes these letters of
credit with cash deposits made with certain of its financial institutions and
has classified these cash deposits as other assets on the Company's balance
sheet as of December 31, 2002 and March 31, 2002. The Company's landlords are
able to withdraw on each respective letter of credit in the event that the
Company is found to be in default of its obligations under each of its operating
leases.
The Company generally does not enter into indemnification agreements
that contingently require the Company to make payments directly to a party that
is indemnified by the Company (an "Indemnified Party"). The Company's
indemnification agreements generally defend and indemnify an Indemnified Party
against adverse situations such as, for example, defense against plaintiffs in a
lawsuit brought by a third party. In all such cases the Company would make
payments to such third party and/or attorneys if such a third party were
successful in such litigation. Historically, the expenses relating to or arising
from the Company's indemnification agreements have not been significant.
10
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
Restructuring
During the three and nine months ended December 31, 2002, the Company
implemented additional restructuring programs to better align operating expenses
with anticipated revenues. The Company recorded a $940,000 restructuring charge
(the significant majority of which was recorded during the three months ended
June 30, 2002), which consisted of $834,000 in employee severance costs and
$106,000 in equipment write-downs across most of the expense line items in the
Company's consolidated statement of operations for the nine months ended
December 31, 2002. The restructuring programs resulted in a reduction in force
across all company functions of approximately 50 employees. At March 31, 2002,
the Company had $763,000 of accrued restructuring costs (the significant
majority of which were recorded during the three months ended March 31, 2002)
related to monthly rent for excess facility capacity, employee severance
payments and other exit costs. The Company expects to pay out all restructuring
amounts accrued as of December 31, 2002 over the course of the next 12 months.
During the three months ended December 31, 2002, the Company made an
adjustment of $66,000 to its accrued excess facilities costs, which affected its
results of operations for the three and nine months ended December 31, 2002. The
excess facility accrual was originally recorded pursuant to EITF 94-3. The
adjustment is a result of the Company's expectation that, in March 2003, it will
re-occupy certain space it had previously written-off and had not intended to
use until April 2003.
The following table depicts the restructuring activity during the nine
months ended December 31, 2002 (in thousands):
Balance at Expenditures Balance at
March 31, --------------------- December 31,
Category 2002 Additions Cash Non-cash Adjustments 2002
-------- ------ --------- ---- -------- ----------- ------
Excess facilities ........................ $ 460 $ -- $ 361 $ -- $ 66 $ 33
Employee severance ....................... 259 834 1,093 -- -- --
Equipment write-downs .................... -- 106 -- 106 -- --
Other exit costs ......................... 44 -- 9 -- -- 35
------ ------ ------ ------ ------ ------
Total .................................. $ 763 $ 940 $1,463 $ 106 $ 66 $ 68
====== ====== ====== ====== ====== ======
During the nine months ended December 31, 2001, the Company implemented
restructuring programs to better align operating expenses with anticipated
revenues. The Company recorded a $847,000 restructuring charge ($397,000 of
which was recorded during the three months ended June 30, 2001 and $450,000 of
which was recorded during the three months ended September 30, 2001), which
consisted of $345,000 in facility exit costs and $502,000 in employee severance
costs across most of the expense line items in the Company's consolidated
statement of operations for the nine months ended December 31, 2001. The
restructuring programs resulted in a reduction in force across all company
functions of approximately 45 employees. At December 31, 2001, the Company had
$148,000 of accrued restructuring costs related to monthly rent for excess
facility capacity, employee severance payments and other exit costs. The Company
paid these accrued amounts out over the course of the 12 months subsequent to
December 31, 2001.
The following table depicts the restructuring activity during the nine
months ended December 31, 2001 (in thousands):
Balance at
Cash December 31,
Category Additions Expenditures 2001
-------- --------- ---- ----
Excess facilities .................... $345 $284 $ 61
Employee severance ................... 502 415 87
---- ---- ----
Total .............................. $847 $699 $148
==== ==== ====
11
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
The Company has invested significant resources into developing and
marketing its recently introduced application products. The Company believes
that these application products broaden the value proposition to business
software application users and expects to derive future revenues as a result of
these product introductions. The market for the Company's application products
is in a relatively early stage. The Company cannot predict how the market for
its application products will develop, and part of its strategic challenge will
be to convince enterprise customers of the productivity, communications, cost
and other benefits of its application products. The Company's future revenues
and revenue growth rates will depend in large part on its success in creating
market acceptance for its application products. If the Company fails to do so,
its products and services will not achieve widespread market acceptance, and may
not generate significant revenues to offset its development, sales and marketing
costs, which will hurt its business. This could lead to the Company taking
additional restructuring actions in order to reduce costs and bring staffing in
line with then anticipated requirements.
Litigation
Beginning on August 22, 2001, purported securities fraud class action
complaints were filed in the United States District Court for the Southern
District of New York. The cases were consolidated and the litigation is now
captioned as In re Virage, Inc. Initial Public Offering Securities Litigation,
Civ. No. 01-7866 (SAS) (S.D.N.Y.), related to In re Initial Public Offering
Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). On or about April 19, 2002,
plaintiffs electronically served an amended complaint. The amended complaint is
brought purportedly on behalf of all persons who purchased the Company's common
stock from June 28, 2000 through December 6, 2000. It names as defendants the
Company; one current and one former officer of the Company; and several
investment banking firms that served as underwriters of the Company's initial
public offering. The complaint alleges liability under Sections 11 and 15 of the
Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, on the grounds that the registration statement for the offering did
not disclose that: (1) the underwriters had agreed to allow certain customers to
purchase shares in the offerings in exchange for excess commissions paid to the
underwriters; and (2) the underwriters had arranged for certain customers to
purchase additional shares in the aftermarket at predetermined prices. The
amended complaint also alleges that false analyst reports were issued. No
specific damages are claimed.
The Company is aware that similar allegations have been made in other
lawsuits filed in the Southern District of New York challenging over 300 other
initial public offerings and secondary offerings conducted in 1999 and 2000.
Those cases have been consolidated for pretrial purposes before the Honorable
Judge Shira A. Scheindlin. On July 15, 2002, the Company (and the other issuer
defendants) filed a motion to dismiss. This motion was heard on November 1,
2002. The Company believes that the allegations against it and the individual
defendants are without merit, and intends to contest them vigorously.
From time to time, the Company may become involved in litigation claims
arising from its ordinary course of business. The Company believes that there
are no claims or actions pending or threatened against it, the ultimate
disposition of which would have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
12
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
NASDAQ National Market Trading Requirements
The Company's stock is currently traded on the NASDAQ National Market.
Under NASDAQ's listing maintenance standards, if the closing bid price of the
Company's common stock is under $1.00 per share for 30 consecutive trading days,
NASDAQ may choose to notify the Company that it may delist its common stock from
the NASDAQ National Market. On October 31, 2002, the Company received notice
from NASDAQ that it is not in compliance with NASDAQ's listing maintenance
standards and that it has until January 29, 2003 to regain compliance. If at any
time before January 29, 2003 the bid price of the Company's common stock closes
at $1.00 per share or more for a minimum of 10 consecutive trading days, NASDAQ
will consider notifying the Company that it complies with the maintenance
standards. If the Company is unable to meet this minimum bid price requirement
by January 29, 2003, the Company expects to have the option of transferring to
the NASDAQ SmallCap Market, which makes available a 180 calendar day extended
grace period for the minimum $1.00 bid price requirement (instead of a 90 day
grace period as provided by the NASDAQ National Market). In addition, the
Company expects that it may also be eligible for an additional 180 calendar day
grace period on the NASDAQ SmallCap Market (ie. until October 27, 2003) provided
that the Company meets the other non-bid price related listing criteria. If the
Company transfers to the NASDAQ SmallCap Market, the Company expects that it may
be eligible to transfer back to the NASDAQ National Market if its bid price
maintains the $1.00 per share requirement for 30 consecutive trading days and it
has maintained compliance with all other continued listing requirements for the
NASDAQ National Market. There can be no assurance that the Company's common
stock will remain eligible for trading on the NASDAQ National Market or the
NASDAQ SmallCap Market. If the Company's stock were delisted, the ability of the
Company's stockholders to sell any of the Company's common stock at all would be
severely, if not completely, limited.
3. Stockholders' Equity
Voluntary Stock Option Cancellation and Re-grant Program
In February 2002, the Company offered a voluntary stock option
cancellation and re-grant program to its employees. The plan allowed employees
with stock options at exercise prices of $5.00 per share and greater to cancel a
portion or all of these unexercised stock options effective February 6, 2002, if
they so chose, provided that should an employee participate, any option granted
to that employee within the six months preceding February 6, 2002 was also
automatically cancelled. On February 6, 2002, 2,678,250 shares with a
weighted-average exercise price of $9.54 per share were cancelled pursuant to
this program. As a result of this program, the Company was required to grant its
employees stock options on August 7, 2002 at the closing market price as of that
date. On August 7, 2002, the Company issued 2,538,250 shares at $0.59 per share
to employees that participated in the Company's Voluntary Stock Option
Cancellation and Re-grant Program.
In addition, the Company had two employees that were eligible to
participate in this program that did not meet certain employee definitional
criteria pursuant to APB Opinion No. 25, "Accounting for Stock Issued to
Employees," as interpreted by the FASB's Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25." Accordingly, the Company had to account for the option grants
to these two participants as though they were non-employees pursuant to EITF
Issue 96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services,"
resulting in the Company recording non-cash, stock-based charges of $87,000 for
the nine months ended December 31, 2002.
13
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
Warrants
In December 2002, the Company entered into an amendment for its
headquarters' operating lease (see Note 2) and issued an immediately
exercisable, non-forfeitable warrant to purchase 200,000 shares of common stock
at $0.57 per share. The warrant expires in December 2005. The value of the
warrant was estimated to be $86,000 and was based upon a Black-Scholes valuation
model with the following assumptions: risk free interest rate of 1.9%, no
dividend yield, volatility of 130%, expected life of three years, exercise price
of $0.57 and fair market value of $0.57. The non-cash amortization of the
warrant's value is being recorded as rent expense over the life of the lease.
During the three and nine months ended December 31, 2002, the Company recorded
$2,000 as rent expense related to this warrant.
In December 2000, the Company entered into a services agreement with a
customer and issued an immediately exercisable, non-forfeitable warrant to
purchase 200,000 shares of common stock at $5.50 per share. The warrant expires
in December 2003. The value of the warrant was estimated to be $648,000 and was
based upon a Black-Scholes valuation model with the following assumptions: risk
free interest rate of 7.0%, no dividend yield, volatility of 90%, expected life
of three years, exercise price of $5.50 and fair market value of $5.38. The
non-cash amortization of the warrant's value was recorded against service
revenues as revenues from services were recognized over the one-year services
agreement. During the three months and nine months ended December 31, 2001, the
Company recorded $216,000 and $648,000, respectively, as contra-service revenues
representing the pro-rata amortization of the warrant's value for the
aforementioned periods (none during the three or nine months ended December 31,
2002).
4. Segment Reporting
The Company has two reportable segments: the sale of software and
related software support services ("software") and the sale of its application
and professional services which includes set-up fees, professional services
fees, video processing fees, and application hosting fees ("application and
professional services"). The Company's Chief Operating Decision Maker ("CODM")
is the Company's Chief Executive Officer who evaluates performance and allocates
resources based upon total revenues and gross profit (loss). Discrete financial
information for each segment's profit and loss and each segment's total assets
is not provided to the Company's CODM, nor is it tracked by the Company.
14
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
Information on the Company's reportable segments for the three and nine
months ended December 31, 2002 and 2001 are as follows (in thousands):
Three Months Ended Nine Months Ended
December 31, December 31,
------------------ ------------------
2002 2001 2002 2001
------- ------- ------- -------
Software:
Total revenues .................... $ 2,002 $ 2,158 $ 6,635 $ 8,536
Total cost of revenues ............ 375 361 1,107 1,121
------- ------- ------- -------
Gross profit ...................... $ 1,627 $ 1,797 $ 5,528 $ 7,415
======= ======= ======= =======
Application and Professional Services:
Total revenues .................... $ 1,312 $ 2,630 $ 3,191 $ 4,988
Total cost of revenues ............ 910 1,968 2,743 (6,625)
------- ------- ------- -------
Gross profit (loss) ............... $ 402 $ 662 $ 448 $(1,637)
======= ======= ======= =======
The Company expects to incur a charge of $1,858,000 during the three
months ended March 31, 2003 related to a planned facility consolidation (see
Note 2). Of this amount, the Company expects that approximately $93,000 will
relate to the Company's software segment and approximately $261,000 will relate
to the Company's application and professional services segment.
5. Income Taxes
The Company has not recorded a provision for federal and state or
foreign income taxes for the three and nine months ended December 31, 2002 or
2001 because the Company has experienced net losses since inception, which have
resulted in deferred tax assets. The Company has recorded a valuation allowance
against all deferred tax assets as a result of uncertainties regarding the
realization of the balances, which only may occur through future taxable
profits.
15
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2002
(unaudited)
6. Subsequent Events
NASDAQ National Market Trading Requirements
On January 30, 2003, the NASDAQ Stock Market submitted a proposal to
the U.S. Securities and Exchange Commission ("SEC") to extend its pilot program
governing bid price rules for all companies listed on the NASDAQ National Market
and also proposed additional bid price rules for all companies listed on the
NASDAQ SmallCap Market. Under the National Market proposal, NASDAQ will extend
the bid price grace period of its pilot program for all National Market issuers
from 90 calendar days to 180 calendar days. In addition, the NASDAQ Small Cap
Market has proposed to increase its pilot program by an additional 180 day grace
period to gain compliance with the minimum bid price listing requirements
(provided that certain other non-bid price related criteria are met by the
registrant). The SEC must approve all of the NASDAQ's proposals prior to the
proposals becoming effective.
As described in Note 2 above, the Company received a letter on October
31, 2002 that it was not in compliance with the NASDAQ's minimum bid price
listing requirement. Based upon NASDAQ's proposed changes, which still require
SEC approval, the Company believes that it may have until approximately April
29, 2003 to regain compliance with the minimum bid price listing requirement. If
the Company is unable to meet this minimum bid price listing requirement by
April 29, 2003, the Company expects that it may have the option of transferring
to the NASDAQ SmallCap Market. Based upon a separate NASDAQ proposal that also
requires SEC approval, the NASDAQ SmallCap market would make available up to two
additional 180 calendar day extended grace periods (ie. until approximately
April 23, 2004) to meet the minimum $1.00 bid price requirement provided the
Company is able to meet certain financial related criteria. If the Company
transfers to the NASDAQ SmallCap Market, the Company expects that it may be
eligible to transfer back to the NASDAQ National Market if its bid price
maintains the $1.00 per share requirement for 30 consecutive trading days and it
has maintained compliance with all other continued listing requirements for the
NASDAQ National Market.
Should the SEC not approve the NASDAQ's proposals and/or should the
Company receive a letter from NASDAQ informing the Company that it will be
delisted due to noncompliance with the National Market's minimum bid price
requirement, the Company believes it will have the opportunity to transfer to
the NASDAQ Small Cap Market. From the date of receipt of such a NASDAQ delisting
letter, the Company believes it would have 90 days to attempt to regain
compliance while trading on the NASDAQ SmallCap Market. In addition, the Company
expects that it may also be eligible for an additional 180 calendar day grace
period on the NASDAQ SmallCap Market provided that the Company meets the other
non-bid price related listing criteria.
There can be no assurance that the SEC will approve NASDAQ's proposals,
that the Company will comply with other non-bid price related listing criteria
or that the Company's common stock will remain eligible for trading on the
NASDAQ National Market or the NASDAQ SmallCap Market. If the Company's stock
were delisted, the ability of the Company's stockholders to sell any of the
Company's common stock at all would be severely, if not completely, limited.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the "Selected
Consolidated Financial Data", the condensed consolidated financial statements
and related notes contained herein. This discussion contains forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. We may identify these statements by the use of words
such as "believe", "expect", "anticipate", "intend", "plan" and similar
expressions. These forward-looking statements involve several risks and
uncertainties. Our actual results may differ materially from those set forth in
these forward-looking statements as a result of a number of factors, including
those described under the caption "Risk Factors" herein. These forward-looking
statements speak only as of the date of this report, and we caution you not to
rely on these statements without also considering the risks and uncertainties
associated with these statements and our business as addressed elsewhere in this
report.
Virage, Inc. is a provider of software products, professional services
and application services that enable owners of rich-media and video assets to
more effectively communicate, manage, retrieve and distribute these rich-media
assets for improved productivity and communications. Depending on their
particular needs and resources, our customers may elect to license our software
products or employ our application or professional services. Our customers
include media and entertainment companies, other corporations, government
agencies and educational institutions.
Recent Events
Application Products
During the past year, we introduced new software application products
that are targeted toward a broadened user base within our key markets. VS
Publishing is an application that offers media and entertainment customers a
streamlined workflow for rich-media web publishing, including a simple editorial
control and greater website programming capabilities. VS Webcasting allows
corporations to self-produce live and on-demand webcasting events such as
executive communications, human resource broadcasts and webinars. Finally, VS
Production is an integrated software solution for media and entertainment
enterprises that automates the professional video production process from
acquisition to distribution.
Though we have sold each of these products to date, early demand is
strongest for our VS Webcasting product, particularly from our corporate
enterprise customers. However, our VS Publishing and VS Production products were
released at a later date than VS Webcasting, and we continue to monitor
anticipated market demand and sales success for these products as we evaluate
the allocation and prioritization of our available resources. We may discover
that the marketplace for our application products is not as robust as we had
expected and we may react to this by leaving the development of a product at an
early stage or combining key features of one or more of our application products
into a single product.
We continue to believe that the success of our application products,
particularly VS Webcasting, is critical to our future and have heavily invested
our resources in the development, marketing, and sale of them. The market for
our application products is in a relatively early stage. We cannot predict how
much the market for our application products will develop, and part of our
strategic challenge will be to convince enterprise customers of the
productivity, communications, cost, and other benefits of these products. Our
future revenues and revenue growth rates will depend in large part on our
success in creating market acceptance for one or more of our application
products.
17
Facility Lease Amendment
In December 2002, we amended our lease for our headquarters (the "Lease
Amendment"). The Lease Amendment reduces, from December 2002 until December
2003, our rent rate to half of what the rent rate was under our original
operating lease agreement. In December 2003, and on each annual anniversary
thereafter through the Amendment's termination date of September 2006, our rent
rate will be adjusted to fair market value as to be mutually determined by us
and our landlord, subject to a minimum rate that is equivalent to the Lease
Amendment's initial reduced rate discussed above (the "Minimum Rate").
In addition, we and our landlord will use best efforts to have our
landlord lease, to a third party, certain space that we intend to abandon in
March 2003. If the space is leased to a third party, the space will be excluded
from the Lease Amendment as of the date an agreement for the third party lease
is executed, subject to our guaranteeing our landlord the Minimum Rate for the
leased space. This guarantee will continue for a minimum of 24 months after the
date of execution for the leased space.
Furthermore, if we are acquired by an unrelated entity, the acquirer
may terminate the lease obligation for a termination fee equal to 67% of the
total minimum monthly rent payable for the remaining term of the lease
subsequent to such acquisition.
In consideration for the above, we issued our landlord a warrant to
purchase 200,000 shares of our common stock at $0.57 per share. In addition, we
will pay our landlord $1,250,000 on January 2, 2003. On March 30, 2003, our
landlord will release back to us $1,250,000 of $2,000,000 of restricted cash
used to collateralize a letter of credit. We will also forego approximately
$240,000 of security deposits by March 31, 2003. The $2,000,000 of restricted
cash and $240,000 of security deposits are classified as other assets on our
consolidated balance sheets as of December 31, 2002 and March 31, 2002.
We will also be obligated to remit an additional $750,000 to our
landlord if our landlord is able to lease this excess space for the benefit of
the Company. Should this occur, our landlord will cancel our letter of credit in
its entirety and release the final $750,000 of restricted cash back to us. We
estimate we will also incur approximately $325,000 of other various expenses
relating to certain provisions set forth within the Lease Amendment.
In addition, our landlord, under certain limited conditions and
exceptions specified in the Lease Amendment, may have the option to extend the
term of the Lease Amendment for an additional five (5) years, with the base rent
for the renewal term based on fair market value.
We began amortizing the $2,565,000 of payments and other expenses
described above as rent expense over the life of the lease in December 2002. As
noted above, in March 2003, we anticipate abandoning approximately half of our
headquarters facility to facilitate the leasing of the space to a third party.
As a result of this and the Company's early adoption of FAS 146, we expect to
incur charges of approximately $1,858,000 during the three months ended March
31, 2003. The charges are related to the write-off of approximately half of the
unamortized portion of the $2,565,000 of anticipated payments described above
and the accrual of approximately $750,000 relating to the expected leasing of
the excess space to a third party at a rate that is below the Minimum Rate
guarantee.
18
Business Restructuring Charges
During the nine months ended December 31, 2002, we re-evaluated our
cost structure and executed additional restructuring measures designed to reduce
and consolidate operations worldwide. We further reduced headcount and
infrastructure across all functional areas of the company in our continued
efforts to limit our expenses and more closely match our expense and short-term,
anticipated revenue levels. These headcount and infrastructure changes resulted
in a reduction in force of approximately 50 employees worldwide and the
recording of $940,000 in business restructuring charges during the nine months
ended December 31, 2002. A breakdown of our business restructuring charges
during the nine months ended December 31, 2002 and of the remaining
restructuring accrual is as follows:
Balance at Expenditures Balance at
March 31, ---------------------- December 31,
Category 2002 Additions Cash Non-cash Adjustments 2002
-------- ------ --------- ------ -------- ----------- ------
Excess facilities and other .............. $ 504 $ -- $ 370 $ -- $ 66 $ 68
Employee severance ....................... 259 834 1,093 -- -- --
Equipment write-downs .................... -- 106 -- 106 -- --
------ ------ ------ ------ ------ ------
Total .................................. $ 763 $ 940 $1,463 $ 106 $ 66 $ 68
====== ====== ====== ====== ====== ======
Excess Facilities and Other Exit Costs: Excess facilities and other
exit costs relate to lease obligations and closure costs associated with offices
we have vacated as a result of our cost reduction initiatives. Cash expenditures
for excess facilities and other exit costs during the nine months ended December
31, 2002 primarily represent contractual ongoing lease payments. Our management
reviews our facility requirements and assesses whether any excess capacity
exists as part of our on-going financial processes.
During the three months ended December 31, 2002, we made an adjustment
of $66,000 to our accrued excess facilities costs, which affected our results of
operations for the three and nine months ended December 31, 2002. The excess
facility accrual was originally recorded pursuant to the FASB's Emerging Issues
Task Force Issue 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity ("EITF 94-3")." The adjustment is a
result of our expectation that, in March 2003, we will re-occupy certain space
we had previously written-off and had not intended to use until April 2003.
Employee Severance: Employee severance, which includes severance
payments, related taxes, outplacement and other benefits, totaled approximately
$834,000 during the nine months ended December 31, 2002 (representing
approximately 50 terminated employees), and $1,093,000 was paid in cash during
the nine months ended December 31, 2002. Personnel affected by the cost
reduction initiatives during the nine months ended December 31, 2002 include
employees in positions throughout the company in sales, marketing, services,
engineering, and general and administrative functions in all geographies.
Equipment Write-Downs: As part of our cost restructuring efforts, we
decided to substantially downsize our subsidiary in the United Kingdom,
primarily in response to weak market conditions in Europe. Pursuant to these
efforts, we reduced our European asset infrastructure by reducing assets
previously used by terminated employees. This resulted in a write-off of
approximately $106,000 of assets at net book value. Our management reviews its
equipment requirements and assesses whether any excess equipment exists as part
of our on-going financial processes.
19
Voluntary Stock Option Cancellation and Re-grant Program
In February 2002, we canceled 2,678,250 stock options of certain
employees who elected to participate in our voluntary stock option cancellation
and re-grant program. Many of our employees canceled stock options that had
significantly higher exercise prices in comparison to where our common stock
price currently trades. On August 7, 2002, we issued 2,538,250 stock options to
current employees who participated in the program with a new exercise price
equal to $0.59 per share.
We believe that this program has helped, and will continue to help, to
retain our employees and to improve our workforce morale. However, this program
may cause dilution to our existing stockholder base, which may cause our stock
price to fall.
Critical Accounting Policies & Estimates
The discussion and analysis of our financial position and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States. The preparation of these consolidated financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, and expenses, and related disclosure of
contingent assets and liabilities. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Estimates and assumptions are reviewed as
part of our management's on-going financial processes. Actual results may differ
from these estimates under different assumptions and conditions.
We believe our critical accounting policies and estimates include
accounting for revenue recognition and the accounting and related estimates for
our commitments and contingencies.
Revenue Recognition
We enter into arrangements for the sale of licenses of software
products and related maintenance contracts, application services and
professional services offerings; and also receive revenues under U.S. government
agency research grants. Service revenues include revenues from maintenance
contracts, application services, and professional services. Other revenues are
primarily U.S. government agency research grants.
Our revenue recognition policy is in accordance with the American
Institute of Certified Public Accountants' ("AICPA") Statement of Position No.
97-2 ("SOP 97-2"), "Software Revenue Recognition", as amended by Statement of
Position No. 98-4, "Deferral of the Effective Date of SOP 97-2, "Software
Revenue Recognition"" ("SOP 98-4"), and Statement of Position No. 98-9,
"Modification of SOP No. 97-2 with Respect to Certain Transactions" ("SOP 98-9")
and is also consistent with the Securities and Exchange Commission's Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." For
each arrangement, we determine whether evidence of an arrangement exists,
delivery has occurred, the fee is fixed or determinable, and collection is
probable. If any of these criteria are not met, revenue recognition is deferred
until such time as all criteria are met. We consider all arrangements with
payment terms extending beyond twelve months and other arrangements with payment
terms longer than normal not to be fixed or determinable. If collectibility is
not considered probable, revenue is recognized when the fee is collected.
Generally, no customer has the right of return.
Arrangements consisting of license and maintenance. For those contracts
that consist solely of license and maintenance, we recognize license revenues
based upon the residual method after all elements other than maintenance have
been delivered as prescribed by SOP 98-9. We recognize maintenance revenues over
the term of the maintenance contract as vendor specific objective evidence of
fair value for maintenance exists. In accordance with paragraph ten of SOP 97-2,
vendor specific objective evidence of fair value of maintenance is determined by
reference to the price the customer will be required to pay when it is sold
separately (that is, the renewal rate). Customers that enter into maintenance
contracts have the ability to renew such contracts at the renewal rate.
Maintenance contracts are typically one year in duration. Revenue is recognized
on a per copy basis for licensed software when each copy of the license
requested by the customer is delivered.
20
Revenue is recognized on licensed software on a per user or per server
basis for a fixed fee when the product master is delivered to the customer.
There is no right of return or price protection for sales to domestic and
international distributors, system integrators, or value added resellers
(collectively, "resellers"). In situations where the reseller has a purchase
order or other contractual agreement from the end user that is immediately
deliverable upon, we recognize revenue on the shipment to the reseller, if other
criteria in SOP 97-2 are met, since we have no risk of concessions. We defer
revenue on shipments to resellers if the reseller does not have a purchase order
or other contractual agreement from an end user that is immediately deliverable
upon or other criteria in SOP 97-2 are not met. We recognize royalty revenues
upon receipt of the quarterly reports from the vendors.
When licenses and maintenance are sold together with professional
services such as consulting and implementation, license fees are recognized upon
shipment, provided that (1) the criteria in the previous paragraph have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional services, and (3) the services do not include significant
alterations to the features and functionality of the software.
Should professional services be essential to the functionality of the
licenses in a license arrangement which contains professional services or should
an arrangement not meet the criteria mentioned above, both the license revenues
and professional service revenues are recognized in accordance with the
provisions of the AICPA's Statement of Position No. 81-1, "Accounting for
Performance of Construction Type and Certain Production Type Contracts" ("SOP
81-1"). When reliable estimates are available for the costs and efforts
necessary to complete the implementation services and the implementation
services do not include contractual milestones or other acceptance criteria, we
account for the arrangements under the percentage of completion contract method
pursuant to SOP 81-1 based upon input measures such as hours or days. When such
estimates are not available, the completed contract method is utilized. When an
arrangement includes contractual milestones, we recognize revenues as such
milestones are achieved provided the milestones are not subject to any
additional acceptance criteria.
Application services. Application services revenues consist primarily
of account set-up, web design and integration fees, video processing fees and
application hosting fees. Account set-up, web design and integration fees are
recognized ratably over the contract term, which is generally six to twelve
months. We generate video processing fees for each hour of video that a customer
deploys. Processing fees are recognized as encoding, indexing and editorial
services are performed and are based upon hourly rates per hour of video
content. Application hosting fees are generated based on the number of video
queries processed, subject to monthly minimums. We recognize revenues on
transaction fees that are subject to monthly minimums on a monthly basis since
we have no further obligations, the payment terms are normal and each month is a
separate measurement period.
Professional services. We provide professional services such as
consulting, implementation and training services to our customers. Revenues from
such services, when not sold in conjunction with product licenses, are generally
recognized as the services are performed provided all other revenue recognition
criteria are met.
Other revenues. Other revenues consist primarily of U.S. government
agency research grants that are best effort arrangements. The
software-development arrangements are within the scope of the Financial
Accounting Standards Board's Statement of Financial Accounting Standards No. 68,
"Research and Development Arrangements." As the financial risks associated with
the software-development arrangement rest solely with the U.S. government
agency, we recognize revenues as the services are performed. The cost of these
services is included in cost of other revenues. The Company's contractual
obligation is to provide the required level of effort (hours), technical
reports, and funds and man-hour expenditure reports.
21
We follow very specific and detailed guidelines, discussed above, in
determining revenues; however, certain judgments and estimates are made and used
to determine revenue recognized in any accounting period. Material differences
may result in the amount and timing of revenue recognized for any period if
different conditions were to prevail. For example, in determining whether
collection is probable, we assess each customer's ability and intent to pay. Our
actual experience with respect to collections could differ from our initial
assessment if, for instance, unforeseen declines in the overall economy occur
and negatively impact our customers' financial condition. To date, we believe
that our revenue recognition has been proper and our related reserves have been
sufficient.
Commitments and Contingencies
In the normal course of business, we are subject to commitments and
contingencies, including operating leases, restructuring liabilities, and legal
proceedings and claims that cover a wide range of matters, including
securities-related litigation and other claims in the ordinary course of
business. We record accruals for such contingencies based upon our assessment of
the probability of occurrence and, where determinable, an estimate of the
liability. We consider many factors in making these assessments including past
history and the specifics of each matter. We believe that there are no claims or
actions pending or threatened against us that would have a material adverse
effect on our operating results. Further, we review our assessment of the
likelihood of loss on any outstanding contingencies as part of our management's
on-going financial processes. However, actual results may differ from these
estimates under different assumptions and conditions.
In July 2002, the FASB issued Statement of Financial Accounting
Standards No. 146, "Accounting for Costs Associated with Exit and Disposal
Activities ("FAS 146")." This statement revises the accounting for exit and
disposal activities under EITF 94-3 by spreading out the reporting of expenses
related to restructuring activities. Commitment to a plan to exit an activity or
dispose of long-lived assets will no longer be sufficient to record a one-time
charge for most anticipated costs. Instead, companies will record exit or
disposal costs when they are "incurred" and can be measured at fair value, and
they will subsequently adjust the recorded liability for changes in estimated
cash flows. Companies may not restate previously issued financial statements for
the effect of the provisions of FAS 146 and liabilities that a company
previously recorded under EITF 94-3 are grandfathered. Based upon the facts and
circumstances around charges that we historically have been required to record,
we currently believe that the adoption of FAS 146 may affect the timing of, but
ultimately will not have a materially different impact on, our operations,
financial position or cash flows as the accounting treatment under the
provisions of FAS 146 are not dissimilar to those prescribed under EITF 94-3.
During the three months ended December 31, 2002, we early adopted FAS
146 and we also adopted a plan that calls for us to consolidate certain
headquarters facilities in March 2003. As a result of this early adoption of FAS
146, approximately $1,858,000 of charges related to the our planned facility
consolidation will be recorded as of the date we cease use of the space we
intend to abandon (March 2003) instead of the plan adoption date (December 2002)
as prescribed under EITF 94-3.
At December 31, 2002, we have contractual and commercial commitments
not included on our balance sheet primarily for our San Mateo, California
facility that we have an obligation to lease through September 2006. For the
remainder of the fiscal year ended March 31, 2003, our total commitments amount
to $2,290,000. Future full fiscal year commitments are as follows: $3,166,000 in
2004, $1,972,000 in 2005, $1,715,000 in 2006 and $1,057,000 in 2007 ($10,200,000
in total commitments as of December 31, 2002). The aforementioned amounts
include our best estimate of expected fair market rental rates in fiscal years
ending March 31, 2004 to March 31, 2007 and if we underestimate these fair
market rental rates, the amount of our contractual commitments will increase.
The aforementioned amounts also include payments of cash and forfeiture of other
collateral of $1,489,000 and $1,076,000 for the years ending March 31, 2003 and
2004, respectively, pursuant to the Lease Amendment described above.
From time to time, we may become involved in litigation claims arising
from our ordinary course of business. We provide further detail about one of
these claims in the notes to our condensed consolidated financial statements
included elsewhere in this quarterly report. We believe that there are no claims
or actions pending or threatened against us, the ultimate disposition of which
would have a material adverse effect on the our consolidated financial position,
results of operations or cash flows.
22
Results of Operations
The following table sets forth consolidated financial data for the
periods indicated, expressed as a percentage of total revenues:
Three Months Ended Nine Months Ended
December 31, December 31,
------------------------------- ------------------------------
2002 2001 2002 2001
------------ ------------- ------------- -------------
Revenues:
License revenues.................... 40 % 31 % 47 % 46 %
Service revenues.................... 60 69 53 52
Other revenues...................... -- -- -- 2
------------ ------------- ------------- -------------
Total revenues.................... 100 100 100 100
Cost of revenues:
License revenues.................... 6 4 5 4
Service revenues.................... 33 45 34 52
Other revenues...................... -- -- -- 1
------------ ------------- ------------- -------------
Total cost of revenues............ 39 49 39 57
------------ ------------- ------------- -------------
Gross profit.......................... 61 51 61 43
Operating expenses:
Research and development............ 54 44 67 51
Sales and marketing................. 71 80 93 94
General and administrative.......... 29 27 32 29
Stock-based compensation............ 8 15 11 17
------------ ------------- ------------- -------------
Total operating expenses.......... 162 166 203 191
------------ ------------- ------------- -------------
Loss from operations.................. (101) (115) (142) (148)
Interest and other income, net........ 3 6 5 9
------------ ------------- ------------- -------------
Net loss.............................. (98)% (109)% (137)% (139)%
============= ============= ============= =============
We incurred net losses of $3,262,000 and $13,506,000 during the three
and nine months ended December 31, 2002, respectively. As of December 31, 2002,
we had an accumulated deficit of $102,430,000. We expect to continue to incur
operating losses for the foreseeable future. In view of the rapidly changing
nature of our market and our limited operating history, we believe that
period-to-period comparisons of our revenues and other operating results are not
necessarily meaningful and should not be relied upon as indications of future
performance. Our historic revenue growth rates have not been sustainable and are
not necessarily indicative of future growth.
Revenues. Total revenues decreased to $3,314,000 for the three months
ended December 31, 2002 from $4,788,000 for the three months ended December 31,
2001, a decrease of $1,474,000 or 31%. Total revenues decreased by $3,698,000 or
27% to $9,826,000 for the nine months ended December 31, 2002 from $13,524,000
for the nine months ended December 31, 2001. These decreases were due to
decreases in license, service, and other revenues. International revenues
increased to $1,025,000, or 31% of total revenues, for the three months ended
December 31, 2002 from $799,000, or 17% of total revenues, for the three months
ended December 31, 2001. International revenues decreased in absolute dollars to
$2,569,000, or 26% of total revenues, for the nine months ended December 31,
2002 from $3,413,000, or 25% of total revenues, for the nine months ended
December 31, 2001. No customer constituted more than 10% of total revenues for
the three or nine months ended December 31, 2002. Sales to one customer
accounted for 30% of total revenues for the three months ended December 31, 2001
and sales to two customers (one of whom was a reseller of our products)
accounted for 15% and 11%, respectively, of total revenues for the nine months
ended December 31, 2001.
23
License revenues decreased to $1,339,000 during the three months ended
December 31, 2002 from $1,478,000 during the three months ended December 31,
2001, a decrease of $139,000 or 9%. License revenues decreased by $1,669,000 or
27% to $4,623,000 during the nine months ended December 31, 2002 from $6,292,000
during the nine months ended December 31, 2001. These decreases are primarily
due to lower unit sales of our platform products, particularly sales of our
SmartEncode product suite to the media and entertainment marketplace. The media
and entertainment marketplace was our weakest market for software licenses
during the three months ended December 31, 2002. Historically, the media and
entertainment marketplace has been our strongest market for software licenses.
We believe the reduction in revenues for our platform products during the three
and nine months ended December 31, 2002 is primarily a function of unfavorable
global macroeconomic conditions affecting a number of our potential customers in
markets such as media and entertainment and resulting in weak demand for
information technology products.
Service revenues decreased to $1,975,000 for the three months ended
December 31, 2002 from $3,290,000 for the three months ended December 31, 2001,
a decrease of $1,315,000. Service revenues decreased by $1,797,000 to $5,203,000
for the nine months ended December 31, 2002 from $7,000,000 for the nine months
ended December 31, 2001. These decreases are primarily the result of lower
revenues in our application services business, primarily due to the non-renewal
of our application services contract with Major League Baseball Advanced Media
("MLBAM"). Service revenues during the three and nine months ended December 31,
2001 include $216,000 and $648,000, respectively, of warrant amortization
recorded as contra-service revenues resulting from a warrant issued to MLBAM.
Other revenues were $20,000 and $232,000 during the three and nine
months ended December 31, 2001 (none during the three and nine months ended
December 31, 2002). These decreases were primarily attributable to the level of
engineering research services performed pursuant to a federal government
research grant.
Cost of Revenues. Cost of license revenues consists primarily of
royalty fees for third-party software products integrated into our products. Our
cost of service revenues includes personnel expenses and other direct costs,
related overhead, communication expenses and capital depreciation costs for
maintenance and support activities and application and professional services.
Our cost of other revenues primarily includes engineering personnel expenses and
related overhead for engineering research for government projects. Total cost of
revenues decreased to $1,285,000, or 39% of total revenues, for the three months
ended December 31, 2002 from $2,329,000, or 49% of total revenues, for the three
months ended December 31, 2001. Total cost of revenues decreased to $3,850,000,
or 39% of total revenues, for the nine months ended December 31, 2002 from
$7,746,000, or 57% of total revenues, for the nine months ended December 31,
2001. These decreases in total cost of revenues were due primarily to decreases
in our cost of service revenues during the three and the nine months ended
December 31, 2002. We expect our total cost of revenues to increase during our
fourth fiscal quarter in comparison to our third fiscal quarter ended December
31, 2002 due to the allocation of the one-time charge to be recorded in
connection with our restructured San Mateo office lease (as discussed under
"Facility Lease Amendment" above). Excluding the one-time effects of this
facility charge, we generally expect that increases or decreases in the dollar
amount of our total cost of revenues will correlate with increases or decreases
in the dollar amount of our total revenues. However, our total cost of revenues
is highly variable and has, in the past, been inconsistent with our
expectations.
Cost of license revenues decreased to $195,000, or 15% of license
revenues, during the three months ended December 31, 2002 from $202,000, or 14%
of license revenues, during the three months ended December 31, 2001. This
decrease (in absolute dollars) was due to lower unit sales of our products that
are subject to unit-based (rather than fixed-fee) license royalty payments for
the three months ended December 31, 2002 in comparison to the three months ended
December 31, 2001. For the nine months ended December 31, 2002, cost of license
revenues increased to $542,000, or 12% of license revenues, from $534,000, or 8%
of license revenues, during the same period in the prior year. This increase
during the nine months ended December 31, 2002 was primarily due to the
introduction of our new application products and other recently introduced
products during our fiscal year 2003 for which we incur a unit-based royalty to
certain technology providers. These additional unit-based royalties paid in
fiscal 2003 were incremental to fixed royalties paid to our historical
technology providers in fiscal 2002 and fiscal 2003.
24
Cost of service revenues decreased to $1,090,000, or 55% of service
revenues, for the three months ended December 31, 2002 from $2,122,000, or 65%
of service revenues for the three months ended December 31, 2001. For the nine
months ended December 31, 2002, cost of service revenues decreased to
$3,308,000, or 64% of service revenues, from $7,059,000, or 101% of service
revenues for the nine months ended December 31, 2001. These decreases were due
to lower expenditures for our application services business, primarily due to
the non-renewal of our contract with MLBAM, which allowed us to reduce our
headcount and infrastructure costs and better aligned our cost structure with
our current revenue levels.
Cost of other revenues was $5,000 and $153,000, or 25% and 66% of other
revenues, during the three and nine months ended December 31, 2001, respectively
(none for the three and nine months ended December 31, 2002). These decreases
were attributable to the level of engineering research services performed
pursuant to federal government research contracts.
Research and Development Expenses. Research and development expenses
consist primarily of personnel and related costs for our product development
efforts. Research and development expenses decreased to $1,781,000, or 54% of
total revenues, for the three months ended December 31, 2002 from $2,117,000, or
44% of total revenues, for the three months ended December 31, 2001. For the
nine months ended December 31, 2002, research and development expenses decreased
to $6,607,000, or 67% of total revenues, from $6,934,000, or 51% of total
revenues, for the nine months ended December 31, 2001. The decreases in absolute
dollars were primarily due to reduced payroll and related expenses resulting
from lower headcount due primarily to our restructuring initiatives in fiscal
2003. We expect research and development expenses to increase during our fourth
fiscal quarter due to the allocation of the one-time charge to be recorded in
connection with the restructured San Mateo office lease (as discussed under
"Facility Lease Amendment" above). Excluding the one-time effects of this
facility charge, we expect that our quarterly research and development expenses
will remain relatively consistent with our third fiscal quarter ended December
31, 2002. To date, we have not capitalized any software development costs as
they have been insignificant after establishing technological feasibility.
Sales and Marketing Expenses. Sales and marketing expenses consist of
personnel and related costs for our direct sales force, pre-sales support and
marketing staff, and marketing programs including trade shows and seminars.
Sales and marketing expenses decreased to $2,357,000, or 71% of total revenues,
during the three months ended December 31, 2002 from $3,858,000, or 80% of total
revenues, during the three months ended December 31, 2001. Sales and marketing
expenses decreased to $9,104,000, or 93% of total revenues, during the nine
months ended December 31, 2002 from $12,720,000, or 94% of total revenues,
during the nine months ended December 31, 2001. These decreases were primarily
due to lower headcount costs due to prior period restructuring efforts and
reduced discretionary marketing program spending. We expect our quarterly sales
and marketing expenses to increase during our fourth fiscal quarter in
comparison to our third fiscal quarter due to the allocation of the one-time
charge to be recorded in connection with the restructured San Mateo office lease
(as discussed under "Facility Lease Amendment" above). Excluding the one-time
effects of this facility charge, we expect our quarterly sales and marketing
expenses to remain in a range of relatively flat to a modest increase in
comparison to our third fiscal quarter ended December 31, 2002, primarily as a
result of variability in our sales personnel's variable compensation programs
and timing of marketing initiatives.
General and Administrative Expenses. General and administrative
expenses consist primarily of personnel and related costs for general corporate
functions, including finance, accounting, legal, human resources, costs of our
external audit firm and costs of our outside legal counsel. General and
administrative expenses decreased to $963,000, or 29% of total revenues, for the
three months ended December 31, 2002 from $1,284,000 or 27% of total revenues,
for the three months ended December 31, 2001. For the nine months ended December
31, 2002, general and administrative expenses decreased to $3,174,000, or 32% of
total revenues, from $3,946,000 or 29% of total revenues, for the nine months
ended December 31, 2001. These decreases in absolute dollars were primarily due
to lower headcount costs as a result of prior period restructuring efforts. We
expect general and administrative expenses to increase during our fourth fiscal
quarter due to the allocation of the one-time charge to be recorded in
connection with the restructured San Mateo office lease (as discussed under
"Facility Lease Amendment" above). Excluding the one-time effects of this
facility charge, we expect our quarterly general and administrative expenses to
increase for the foreseeable future as we incur higher audit, legal and
insurance costs due to a number of external factors including recently passed
legislation such as the Sarbanes-Oxley Act.
25
Stock-Based Compensation Expense. Stock based compensation expense
represents the amortization of deferred compensation (calculated primarily for
stock options granted to our employees prior to the time of our initial public
offering as the difference between the exercise price of the stock options
granted and the then deemed fair value of our common stock). We recognized
stock-based compensation expense of $291,000 and $719,000 for the three months
ended December 31, 2002 and 2001, respectively, and $1,026,000 and $2,257,000
for the nine months ended December 31, 2002 and 2001, respectively, in
connection with the granting of stock options to our employees. Our stock-based
compensation expense decreased during the three and nine months ended December
31, 2002 due to the cancellation of stock options resulting from participation
in our voluntary stock option cancellation and re-grant program for our
employees during the year ended March 31, 2002. The implementation of this
cancellation and re-grant program resulted in the immediate expensing of the
majority of our employee-related deferred compensation in our fourth fiscal
quarter of 2002. As a result, our fiscal 2003 and future stock-based
compensation expenses are, and are expected to continue to be, lower than fiscal
2002 levels. We will continue to amortize the remaining deferred compensation
balance as expense for employees who did not participate in our voluntary stock
option cancellation and re-grant program.
Interest and Other Income. Interest and other income include interest
income from cash, cash equivalents and short-term investments. Interest and
other income decreased to $101,000 and $429,000 for the three and nine months
ended December 31, 2002, respectively, from $315,000 and $1,295,000 for the
three and nine months ended December 31, 2001. These decreases were a result of
lower interest rates and lower average cash balances during the three and nine
months ended December 31, 2002.
Provision for Income Taxes. We have not recorded a provision for any
significant federal and state or foreign income taxes in either the three or
nine months ended December 31, 2002 or 2001 because we have experienced net
losses since inception, which have resulted in deferred tax assets. We have
recorded a valuation allowance for the entire deferred tax asset as a result of
uncertainties regarding the realization of the asset balance through future
taxable profits.
Liquidity and Capital Resources
As of December 31, 2002, we had cash, cash equivalents and short-term
investments of $18,872,000, a decrease of $11,822,000 from March 31, 2002 and
our working capital, defined as current assets less current liabilities, was
$13,628,000, a decrease of $10,449,000 in working capital from March 31, 2002.
The decrease in our cash, cash equivalents, and short-term investments and our
working capital is primarily attributable to cash used in our operating
activities.
Our operating activities resulted in net cash outflows of $11,887,000,
and $13,429,000 for the nine months ended December 31, 2002 and 2001,
respectively. The cash used in these periods was primarily attributable to net
losses of $13,506,000 and $18,784,000 in the nine months ended December 31, 2002
and 2001, respectively, offset by depreciation expense, losses on disposals of
assets, and non-cash, stock-based charges. Investing activities resulted in cash
inflows of $9,953,000 and cash outflows of $32,000 for the nine months ended
December 31, 2002 and 2001, respectively. Our investing activity cash infl